Following last week’s SPY hedging suggestion in?”January Barometer 2014″ required close monitoring and would have probably been closed on Friday for a slight loss although it had yet not reached the?SU?(stop/unwind) at 180 it looked like the momentum was likely to carry it still higher.
Now until the potential Head & Shoulders Top pattern is resolved we suggest preparing another put spread anticipating the formation of the right shoulder. While it may seem unlikely based upon the signals given from the SPX options as well as the VIX Futures and options, the downside in the event it happens is too great to ignore. We suggest it is better to be prepared for the decline that may not come than to reload longs after just a two-day bounce.
Earnings Volatility Suggestion
While reviewing the results of our Rankers & Scanners page we noticed one of our Volatility Kings? was number four in the high IV/HV ratio group and decided to take a further look.
Groupon, Inc.?(GRPN)?Now scheduled to report 4Q earnings on February 20 after the close, with a consensus estimate of .02 with a whisper of .03 the implied volatility has been rising for about three weeks. Based upon previous report dates, it looks like it will continue higher providing an opportunity to participate on both the continuing advance in implied volatility and the post report decline.
The current?Historical Volatility?is 43.74 and 39.19 using the?Parkinson’s range method, with an?Implied Volatility Index Mean?of 77.31, up from 74.99 the week before. The 52-week high was 100.40 on February 11, 2013 while the low was 48.73 on November 15, 2013. The?put-call ratio?at .38 is in bullish territory as Friday’s volume was a respectable 26,504 contracts traded compared to the 5-day average volume of 18,840, so the liquidity should be workable.
The plan is to be long volatility going into the report with a March 12 call.
Then on February 19 before the report date,
?
In the event the stock has risen above 11 by the report date, sell a Mar 11 put in lieu of Mar 10 above. Understand there is risk of assignment in the case it declines after reporting. In the meanwhile, should the stock decline below 10 before the report, close the long call.
Takeover File
It has been sometime since we have seen viable takeover activity, so we were pleased to see two companies in the 52-week high IV range category last week that are currently in talks.
Sprint Corporation?(S), and?T-Mobile US, Inc.?(TMUS)
On Wednesday last week, it was announced Sprint, with a market capitalization of 31.5 billion was arranging 45 billion of debt in an effort to buy T-Mobile US, Inc. with a market capitalization of 22.2 billion and 21billion of debt. Both stocks along with their options implied volatilities advanced on the news, but then pulled back at the end of the week as doubts surfaced that regulators would ever approve a deal to combine these companies.
For now, until approved or withdrawn the proposal should keep the implied volatility of T-Mobile high providing an opportunity to sell premium.
Here is the options data.
The current?Historical Volatility?is 40.10 and 34.03 using the?Parkinson’s range method, with an?Implied Volatility Index Mean?of 59.95, up from 56.87 the week before. The 52-week high was 65.19 on February 3, 2014 while the low was 27.83 last April 24. The?put-call ratio?at .40 is just bullish while Friday’s volume was only 4,435 contracts traded compared to the 5-day average volume of 30,570.
Consider this long call spread – short put combination.
This is an inexpensive way to see if the regulatory issues will be resolved allowing this combination to proceed. Use a close back below the last pivot at 29 as the?SU?(stop/unwind). The options liquidity is not great so be careful with the bid/ask spreads.
The suggestions above use the closing middle price between the Friday bid and ask. Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.
Summary
As the S&P 500 Index declined last week it seems to have “walked the line”, finding support at the upward sloping trendline that seems to have reversed the decline. Now it needs to resolve the potential Head & Shoulders Top that could still turn this modest pullback into a long awaited full-blown correction. We suggest preparing for the development of a possible right shoulder that would define the downside risk should it occur.